Article excerpt

Researchers in behavioural finance establish strong influence of investor sentiment on asset prices (Baker & Wurgler 2006). Earlier studies investigated the influence of investor sentiment on asset prices of different sizes of companies (small versus large firms), various countries (developed versus emerging), and various sectors (finance, industrial and properties) (Brown & Cliff 2004; Fauzias, Izani & Rashid 2013). These studies reported strong positive connection between investor sentiment and stock prices. Stock price tends to shoot upward during the state of higher investor sentiment. Investor sentiment is widely determined by the overly optimistic or pessimistic behaviour of the investors. Investor sentiment is also strong when investors rely on noise and invest in stocks that are difficult to arbitrage (Qiu & Welch 2006). The primary proxy to measure investor sentiment came from surveybased studies. Most recent studies employed a combination of surveys and secondary data to measure investor sentiment index.

Islamic finance industry has been growing at a double digit rate every year (E&Y 2013; Hassan, Rashid, Imran & Shahid 2010). The industry is operated on the Islamic shan ah. Islamic shan ah prohibits interest (riba), and production and use of alcoholic goods, investment in pornography and anything that oppresses basic human rights (Hassan & Rashid 2010). Islamic finance prohibits investment that involves excessive uncertainty (gharah) and gambling (mysir). Islam also prohibits trading on goods that do not have physical existence (Chapra 1985). Islam advocates the value of entrepreneurship, production through integrity and hard work, and prefers equity than debt (Farooq 2007). Consequently, partnership, mutual solidarity and brotherhood are the symbols of Islamic economic system. It is prohibited by Quran and Hadith for Muslims to act on rumours. As it is clearly found from Surah Hujuraat (Quran 49:6) where Allah (swt) is saying, "O you who believe! If a Faasiq (liar - evil person) comes to you with any news, verify it, lest you should harm people in ignorance, and afterwards you become regretful for what you have done". It is found in Sahih Muslim that the Prophet (pbuh) said, "It is enough sin for a man to speak of everything that he hears". During the day of the Prophet (pbuh) when Sahabat (ra), the companions of the Prophet (pbuh), migrated from Mokkah to Ethiopia, there was a rumour that many people became Muslim in Mokkah, and the Sahabat went back to Mokkah to see them. However, they later found that it was simply a rumour, and they met with persecution at the hands on Quraysh. Finally, in the Kitab al-Buyu, the book of transaction, (Book 10 of Sahih Muslim), explains that Islam prohibits any sort of speculation for the purpose of individual gain at the cost of information disequilibrium or asymmetric information in business. Hence, Muslims, when they are investors or performing some business activities, must verify the information they get, and they must not work on overly optimistic or pessimistic expectations.

Investor sentiment is defined as the propensity to speculate (Barberis, Shleifer & Vishny 1998). Any kind of speculation, either intentional or partaking, is considered haram (not permissible) in Islam. Another common concept of investor sentiment is that sentimental investors value rumours more than fundamentals (Baker, Wurgler & Yuan 2010), which is also against Islamic principles. Long-run significance of investor sentiment may also indicate that irrational investors outperform rational investors (Black 1986). Theoretically, Shan ah compliant stock investment cannot have a long-run significant connection to investor sentiment. Islamic finance should rely on fundamentals, not on rumours. However, if investor sentiment has significant influence on Islamic Shari 'ah stock index, it will probably close the gates for Islamic capital markets. …